Market review

Equity markets fell in October as government bond yields rose over concern about the post-US presidential election outlook for taxes and government expenditure and the impact on US inflation, exacerbated by some market unease around the UK Budget, which led to profit-taking. However, for UK investors in global assets, a 3.6% fall in the value of sterling over the month resulted in a positive outcome.

Against this background, the Trust’s net asset value (NAV) rose 2.7% while its benchmark index, the MSCI All Country World Financials Index, rose 4.4%. The underperformance over the month was due to the combination of an overweight position in the UK and defensive positioning in the US.

US financials

US banks were very strong over the month, rising by 10.7% in sterling terms. Having succumbed to some profit-taking in September – in part following JP Morgan guiding down on earnings expectations – results were solid and the market reacted positively to them. While revenues came in stronger than expected, guidance that net interest income is set to grow in 2025 is a big positive. Comments about asset quality were also reassuring with JP Morgan’s Chief Financial Officer stating on the bank’s call with financial analysts: “Spending patterns [are] consistent with the narrative that the consumer is on a solid footing and consistent with the strong labour market.”

Conversely, insurance stocks materially lagged over the month, largely due to their defensive characteristics. However, Arch Capital was a particular drag on performance; it has been a strong performer over the year to date but gave back some of these gains in October. This reflected a combination of industry concerns on reserves related to social inflation and an unexpected leadership change with the Chief Executive stepping down. We believe the business remains well placed to sustain strong premium growth and underwriting margins, with results later in the month coming in line with expectations.

US banks were very strong over the month, rising by 10.7% in sterling terms.Elsewhere, we have continued to see solid results from our holdings in, for example, alternative asset managers with Blackstone and Ares Management both reporting double-digit growth in assets under management on the back of continued inflows of capital. This is in stark contrast to their traditional asset management peers that (outside the likes of BlackRock, with its exposure to the growth in exchange-traded funds) continue to suffer much more challenging operating conditions.

UK motor finance

Towards the end of the month, the UK Court of Appeal issued a potentially precedent-setting ruling against Close Brothers Group* and MotoNovo (owned by FirstRand Bank*) in relation to historical motor finance commission arrangements. Crucially, the ruling goes beyond the regulatory requirements set out by the UK’s Financial Conduct Authority (FCA), which had already announced an investigation into historical discretionary commission arrangements for motor finance loans back in January. Indeed, while the FCA has required disclosure around the existence of commission arrangements and has banned discretionary commissions since 2021, the Court of Appeal’s ruling requires not only the disclosure of the commission amount, but also the express customer consent should a commission payment have occurred.

While both banks have announced plans to appeal to the UK Supreme Court, the timing of any decision is highly uncertain. The ruling itself also raises considerable uncertainty over the implications of the FCA’s current investigation of historical discretionary commissions and materially increases the likelihood of a scheme of redress to compensate customers. The ruling has also raised the prospect that commission arrangements for other lending products could be affected. As a result of the Court of Appeal ruling, there has been a significant fall in the share price of Close Brothers Group* and to a lesser extent Lloyds Banking Group* but also the shares of some other much smaller UK banks that have significant exposure.

Investment activity

We sold holdings in AIB Group and Banco Santander during the month to pivot the portfolio and increase exposure to the US on the back of the increasing likelihood of a soft landing for its economy and a positive market reaction to the outcome of the US election. We remain overweight European banks and continue to see them as undervalued but in the shorter term felt that there was some downside risk from weaker growth and therefore interest rates that could weigh on share prices. We bought new holdings in Bank of America, US Bancorp and BlackRock.

Outlook

The election of Donald Trump, with the Republican Party also taking control of the Senate and expected to take control of the House of Representatives, should be positive for the financial sector in the expectation of easing regulation for banks and a pickup in merger and acquisition (M&A) activity. The Trump administration’s ability to make leadership changes at federal regulatory agencies, such as the Federal Trade Commission, which oversees anti-trust concerns, will allow it to roll back or abolish regulations and speed up M&A approvals that have been on hold under its current chair Lina Khan, who was appointed by the Democrats in 2021.

Moreover, Republican Senator Tim Scott's role as the next chair of the Senate Banking Committee, will emphasise a notable shift in tone for the committee after Democrat Senator Sherrod Brown's leadership. Scott has been a vocal opponent of the Federal Reserve-led effort to revamp capital requirements for banks. He led a push by 39 Republican senators last year, asking regulators to withdraw the initial Basel III proposal that was put forward in 2023, which would have led to a significant increase in capital requirements for banks.

The playbook from Trump’s election win in 2016 is informative in that there was a significant rally in financials, which lasted around 18 months. The starting point for valuations is higher this time which, all things being equal, may temper the size of any sustained rally. Nevertheless, while the expectation of lower regulatory pressures on banks is indeed positive and a welcome development, the outlook for the US economy, which drives loan demand and credit losses, will exert greater influence on the sector’s longer-term performance. The sector’s valuation, while no longer anomalously cheap in absolute terms, remains at a deep discount to the wider equity market.

* not held